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- [00:00]
A
What's up guys? On this episode of Full Signal, I sit down with Gabriela Santos. She is the chief market strategist for the Americas at J.P. morgan Asset Management. One of the smartest people I know in finance. We get into the country she likes best for the AI trade. The international versus US outperformance story, what's coming next in the Capex boom and much more. I think you're going to love this, Gabriela. You've been doing a lot of work of international versus US equities equipment and my understanding is that you do not believe equity outperformance internationally means the end of US exceptionalism. Can you explain that for me?
- [00:35]
B
That's right. Sometimes when we talk to US based investors about investing internationally, it feels like you have to be a US bear to believe in investing in stocks outside the US and that is not at all the case. We still think the US is absolutely exceptional as an economy. It's extremely resilient, dynamic, competitive. As a market. We have the largest, deepest capital markets, the reserve currency, the largest private capital markets in the world. It's really just about the normalization of the premium we're paying for all that exceptional fundamentals. It's just too high. So normally the US has about a 20% premium. To the rest of the world it's at 35%. Another way to look at this is portfolios are very concentrated in US equities. Normally you would have about 65% in US as a percent of overall global equities. Most investors we talk to have 80, 90% US. So it's all about the starting point, not a change in the ultimate destination. But that's important because that can mean international outperformance for a bit.
- [01:43]
A
Okay, so just to clarify, it sounds like in a way you like you're having your cake and eat it too, right? It sounds like you like both ways, international and us. Is there a way to frame it that you're not bullish on everything?
- [02:00]
B
Yes, and I think this is where it's interesting to think about areas internationally where maybe you might have discounted valuations, they might be under owned, but it's that way for a reason and we don't quite see a catalyst. So that's where it's not international as a whole, but it's really specific stories. Take the China example. It used to be the most exciting story in emerging markets. It's had pretty depressed valuations really since they introduced their 14th Five Year Plan all the way back in early 2021. But we really see this as a different China. It's one that's much more focused on specific growth priorities, not growth at any cost, one that has specific areas it wants capital to go, not overall open to foreign investment. So it deserves a bit of a haircut, it deserves a discount. And we just don't see the catalyst yet for that to really turn around. So that's where the story has really changed in em and we see much other exciting areas.
- [03:08]
A
Are you able to share any of those areas?
- [03:10]
B
So I think these days the giant sucking sound of AI ends up affecting all markets, right? This huge $5 trillion AI CapEx build out. And when you look at emerging markets, North AS is very involved in that. And by that we mean Taiwan and Korea. So the big semiconductor manufacturers for example in Taiwan, as well as the big memory and CPU makers listed over in Korea, they are the picks and shovels involved in this AI CapEx. Which by the way, you cannot have AI in the US without going global, without passing through Asia and then coming back to our data centers in Virginia. So that's a really exciting story. I think you could argue Latin America is somewhat part of the story too with the commodities that are such important inputs into AI, renewable energy, electric vehicles. So Brazil for example, having a bit of a renaissance. So slightly different, but em now being very related to the AI CapEx story.
- [04:17]
A
Okay, so Taiwan, Korea, Brazil. The historical analog here I think is 2000 to 2007 when international really outperformed US equities. In that scenario though, the US had a pretty choppy bear market and downturn. Is it possible that International outperforms Even if the US is compounding at, let's say, 10% a year?
- [04:41]
B
Absolutely. We saw that last year, right. It was the third year of double digit US returns, but international still outperformed by 15 percentage points. So that was the best outperformance since 2009 in a year where we had an amazing run for US equities. And it's a similar situation this year actually. The US is up nearly double digits at this point year to date, nearly that 10%. Yet international as a whole is outperforming by nearly 400 basis points. So again, I don't think you need to be bearish on the US to be bullish. The rest of the world because of that starting point and 2000 to 2007 is a great example. We two ingredients that we see right now, number one is we had less divergence in earnings growth, great earnings growth in the US but the rest of the world kept up the Second thing we had at the time was a weaker dollar still the reserve currency, just expensive and went through a period of weakening which tends to be supportive of international. So those two ingredients seem to be in place and we might already be in year three of this parallel to 2000, 2007.
- [05:56]
A
Well, if I look at the numbers here, Korean equities have pretty much doubled two years in a row.
- [06:00]
B
Yes.
- [06:01]
A
Taiwan's up 40, 50% both years. Is there a specific multiple or maybe changes in the currency or earnings that would make you a seller on international?
- [06:12]
B
Yeah, and I think we're very far from that though if we just think about it's been 15 years of underperformance of international. So two years of good performance isn't going to reverse that. If we have the situation we have right now, which is actually earnings are getting revised up even faster. So take this year, as you mentioned, amazing year again for Korea, Taiwan, or just take em as a whole, it's up nearly 20% year to date, 70% of it due to Korea and Taiwan. But the multiple has actually come down because earnings expectations have been Revised up by 35 percentage points.
- [06:53]
A
So the way to say it in plain language, stocks are getting cheaper, right?
- [06:57]
B
They're getting cheaper because the earnings are really good and actually getting even better than investors expected. Similar dynamic to the U.S. actually, the market is up nearly 10%. But actually the P has come down because we've revised up those earnings. So we're not at the moment where we would look at international stocks and say, you know what, it's gone too far too fast. The multiple just doesn't make sense anymore. This is even true, by the way. If you look by sector, there's a discount internationally, a bigger discount than normal in every single sector. So you can have similar companies to US companies. They've just had kind of a international discount associated with them. The last thing, if I could just mention Korea that you and I are both pretty interested in, besides the memory cpu, whole AI capacity, there's a very specific story there around corporate governance chain changes. So normally Korea has had pretty weak corporate governance, high ratio of cash on balance sheets, for example, but that is really changing similar to what's been happening in Japan. So that might mean average or normal or fair valuation for Korea going forward is actually higher than just if you compare to the last 20 years.
- [08:15]
A
Can you explain that a bit more? What does that mean if they're getting more corporate governance forward? Like what does that mean for stock prices?
- [08:22]
B
It's interesting. So it means the multiple doesn't need to be so discounted. You can have a market like Korea, Japan, China, all countries that we see corporate governance changes commanding a higher multiple because they're fixing the underlying, the return to shareholders, the return on equity. So what's normally pretty cheap, discounted markets can actually all of a sudden become markets that deserve a higher valuation to them. And they're all kind of following the Japan model. It's kind of a carrots and sticks. Carrots. Look, if you make these corporate governance changes, you get to be a part of the good list. ETFs track you, you get rewarded, but they're also sticks. Exchanges might say, look, I'm going to penalize you if you don't change course. Activist investors start building stakes in these companies. So it really forces a whole psychology change. And that's really, really exciting.
- [09:18]
A
Okay. I think that's one angle that I definitely haven't heard much chatter of among investors. Let me ask you about this diversification idea. A lot of people go to emerging markets, international stocks to diversify out of the S&P 500, which is now about a third in the Mag 7.
- [09:36]
B
Yep.
- [09:37]
A
But buying, let's say AI exposure through Asia is really only a handful of stocks as well. So if you have a mix of international and US index funds, you're still, you know, there's maybe a dozen stocks really that you're buying into. This is sort of a pushback on internationals as diversification.
- [09:58]
B
And I think it's a very valid pushback and something that's been a bit concerning year Today we mentioned EM is up nearly 20%, 72% of that return. Three companies, if you just look at, you know, as a share of the Overall index, these three companies represent 25% of all of MSCI emerging markets. So there's a very heavy concentration for good reason. These stocks have done tremendously well because their earnings have just exploded higher on the back of this whole AI capex. But it is a bit concerning because that means you're very exposed to single companies. Right. If I don't know, at some point they disappoint on earnings and then that exposes you to a lot of company specific risk. The other thing I think is important for investors to understand is it's still the same AI theme. So these, Korea, Taiwan, those markets are going to have pretty high correlation or pretty steady movement with US Stocks because it's all kind of the same story. So what does this mean then for diversification? I think the way to look at it is at least you're diversifying the winners. You don't care which hyperscaler wins in the us. You don't care if the US or China wins the AI war. These are companies that are going to actually get a lot of those capex dollars no matter what. So at least you're diversifying the winners and losers part of the AI story a bit more. But if you want true diversification, spare a thought for Europe does not have AI. It's actually tied to other themes. It's value, it's not growth. And that comes in handy when you have sasspocalypse or Deep Seek Monday and AI trades down. European value is actually up. So that's true diversification.
- [11:50]
A
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- [13:17]
B
Yeah, and so I think this is, you know, the whole AI CapEx thesis really rests on. We're still in early to mid innings of all of this money flowing really to data centers and the whole build out of compute which involves all of these semiconductors. Cloud companies elect electronic equipment, hardware. So you have to believe that we haven't topped out yet that the hyperscalers or individual Governments will keep coming out with bigger and bigger announcements for capex. Once you're kind of at the tail end of that, then that probably means the market's going to turn to the next thing. So I like to think of this as like a really long AI series that is going to go through different seasons and we're now in the AI Capex season which eventually will run its course. We just don't quite think we're there at the moment. Where do we expect this to top out? We might need about $5 trillion of AI CapEx by 2030 to actually get all of the compute or all of the power we need to run these LLMs. But it's going to depend on companies feeling like it's worth it.
- [14:33]
A
Right?
- [14:33]
B
You're a small business around the world or your large company feeling like, I still want to adopt AI, so we need all this CapEx, so we need all of these picks and shovels.
- [14:43]
A
Is it possible to really know when the top is in? Let's say, like I know we can project CapEx, but as an investor, like if you're just looking on your brokerage account and you say, I need to know when to get out of this parabolic run, is there anything in the market that can actually signal that right now? Because all the big companies and their earnings, they just say we're going to put billions of billions more into this one thing.
- [15:10]
B
So part of it is the hyperscaler AI CapEx guidance and how much AI revenue they're getting on that CapEx for themselves. But I would go a level deeper than that. Right? The hyperscalers are setting up all of this computer for other businesses to use AI and then lease their cloud services. So one metric we're really watching is AI adoption by businesses small, medium, large around the us when does that top out? When do businesses say, you know what, I've adopted this, it's worth it. It's not. But like I've already scaled up and at the moment when you look at those surveys, only about 20% of businesses say they've actually adopted AI. Seems pretty low, right? Seems like we could see that increase further. It's also going to depend on the cost versus return for them. And that's where we're watching some of these big IPOs coming later this year for some of the large language models. Do they start changing their pricing? They've been subsidizing our usage of AI. Do they actually start charging us the real cost per token? And then maybe businesses rethink that calculation. But so far we feel like we're pretty early on still in that capex build out.
- [16:31]
A
I agree with you. I think we're very early generally in the AI trade, let's say as far as the fundamental story. But also the price action really has barely kept up with the earnings. Exactly in many ways. So I think that's really encouraging. As an investor, what do you make of the semis rally? And we've had a bit of a pullback, but generally the last couple months has been pretty extraordinary.
- [16:53]
B
Extraordinary. Since end of March, semiconductor, the main US ETF is up 60% yet to our previous point, it's gotten cheaper, the valuations have come down and that's because during the earnings season we've just seen companies blow far and away already elevated earnings expectations and those earnings have gotten revised upwards. Just tremendous, tremendous strength. It's, you know, these companies seeing a lot of demand for all different types of semiconductors and, and there's still not enough supplies so they're, they're able to charge higher prices. So it's the volume and the price that's really working well for them. That said, as you know, whenever you see something go up a lot, eventually expectations get pretty high and you get into that what have you done for me lately kind of thing, which means you might get a pullback. But it can be an opportunity as long as fundamentally things haven't changed. And still I think what's interesting also about semiconductors is, is it's not just one company, one type of semiconductor anymore. It's become much broader. It's your GPU, CPUs, memory. So that's also a bit healthier to, to see beneath the surface.
- [18:10]
A
It's been so mind blowing to watch. I mean the charts, they look like dot com charts frankly, like something like Micron has just gone so parabolic and it looks like something you'd see in 1999. But then I have friends text me, they say hey, is Micron still a buy right now? And I say well, you know, it depends on a lot of things but personally I think yes, because it looks very cheap compared to its 27 earnings. Right.
- [18:38]
B
And the earnings charts look so different than the dot com. Right. Because the way that we think about it is back in the dot com you were building all this capacity and fiber and telecom for something that was supposed to happen in the future, like hopes and dreams, this will pay off versus now you're building the capacity and you're actually kind of behind because the demand is already there and more. So you're already seeing it in the earnings and that's what makes it exciting versus kind of dot com scary.
- [19:09]
A
So maybe the way to think about this, is it as simple as supply versus demand?
- [19:16]
B
Some of it is, absolutely. So you have the capacity and then you have the price egg. So when you listen to companies, especially companies in Asia, they're talking about being capacity constrained probably through the end of next year, meaning their order books are just filled to the brim and they can't deliver fast enough. And so when you look at prices for semiconductors, computers, tablets, they've been going through the roof. Eventually, of course, that works itself out and companies increase capacity and the prices normalize. That's where you get to the bigger question of just increasing actual end capacity or compute. So it's the volume is the most important part. The price can be artificially inflated, will normalize in a year, year and a half, but the actual volume of that demand, that's where you're, you're really seeing a big increase.
- [20:11]
A
A lot of people like to address everything you're talking about, and still they will say AI is a bubble. To them. What would you say?
- [20:23]
B
I think it's tricky to say it's a bubble. Right. And, and specifically what, what do we mean by a bubble? Because the Internet was not a bubble. Right. The Internet changed all of our lives. You know, we use the Internet every single day for every single thing. The technology was transformative, but we did end up having a period in the markets where prices of individual companies tied to that theme got a little ahead of their skis in terms of the actual monetization of that big technology. So right now we would not say AI as a technology is a bubble. It's real. Businesses are rushing to incorporate it. It's something we think will really transform productivity for the economy and for companies. And we don't think the stocks for certain of these picks and shovels have gotten ahead of themselves because the earnings are following through. But all that we talked about is very specific to picks and shovels. I think sometimes when you get this excitement, anything can do a little AI pixie dust and see its price get a little parabolic, even though it doesn't necessarily have actual revenues related to AI. And this is where sometimes we look at small caps and we see certain companies that have billed themselves as tied to AI but actually don't have any real revenues to speak of. So they're always going to be bubbles within a broader fundamental theme to be careful with.
- [21:55]
A
I mean, it was only maybe a few weeks Ago we saw allbirds pivot to AI and they went up, you know, 500% or something. That was also crazy.
- [22:04]
B
Great example. And I, yeah, I love Allbirds too. So I wish that I also do.
- [22:08]
A
By the way, a lot of friends wear Allbirds. So I want to ask you, if we were to look back at your last 18 months of work in the market, what have you been wrong on?
- [22:21]
B
So we talked about the importance of valuations. There's a story that we didn't speak of necessarily in emerging markets, markets where we love the story, yet the valuation just wasn't right and still isn't right. And that's where I think it's important to take that into account. And the country we're referring to is India. India is different than China actually. They've delivered strong GDP growth. Multitudes above China now growing about six and a half, seven percent a year. But they've also delivered the earnings to match that GDP growth. So they have one of the highest return on equities of any market. So it's a good story economically, it's a good story in the market. It just got very expensive. If you look at the price to earnings ratio, just through the roof. So the story is still great. But it was due for a bit of a hangover from that high valuation and it did. It's been underperforming for about a year and a half and it's actually negative year to date.
- [23:24]
A
But you were bullish on it a year ago.
- [23:26]
B
We love the story and we were bullish on it. It's just that you have to wait sometimes for the valuation to be right. And if you're already investing in it, that's where position sizing becomes important, right? To not be too overweight, to not have let it ride a little bit too much, to always keep that eye on the valuation.
- [23:45]
A
So with that in mind, what do you think is the potential bearish catalyst that unwinds your international thesis right now?
- [23:53]
B
So I think for emerging market, because it is so tied to AI Capex, it's going to be some kind of misjudgment or mispricing around AI Capex. Maybe actually it's decelerating faster than we expected. Right. Maybe you don't still have a few years of this huge ramp up in demand for semiconductors because it's become so tied to that. That is a big important thesis to have. I think you could have said it would be geopolitics. We have the Iran war this year, we had the tariff war last year. And yet Emerging markets still did really, really well. There were certain countries within that that suffered. But overall it's a much more resilient asset class. So it's no longer the kind of thing we would say anymore.
- [24:43]
A
Well, let me ask you, it sounds like the bear case on internationals is also the same bear case for us.
- [24:50]
B
And I think it's a very related theme. Exactly. It's AI CapEx buildout. Because if you look at performance this year it's like mag seven. What? Mag seven. That was the theme last year. The year before, the year before that it was all about the Capex spenders, the hyperscalers. This year it's been all about the AI CapEx receivers. So it's been in the US semiconductors hardware, which is exactly the theme in North Asia, just like on hyperdrive. So it's all very related. The correlation is going to be very, very high between these two markets.
- [25:27]
A
Is there a way to gain exposure to, I don't know, something that would do well but isn't exposed to AI right now?
- [25:36]
B
I honestly keep going back to Europe.
- [25:39]
A
Okay.
- [25:39]
B
You know, I think people say ah, but Europe is never going to get its act together and it doesn't have these innovative cool tech companies. But you know what? Sometimes diversifying from that tech AI theme is actually a good thing. So let's think about what Europe has different than post financial crisis. It's actually got banks that are as profitable as American banks that have far outperformed US banks and US growth. Why? It was coming from depressed valuations and then you had a big change in scenario. The end of negative interest rates, the end of deflation. So less bad is good when you're coming from depressed valuations. What else does Europe have? Well, finally they ended fiscal austerity, they're doing fiscal spending, they're doing more on defense, on infrastructure. So that means their industrial companies, especially defense related companies have been doing extremely well and are quite interesting to us. So those are unrelated to AI and actually that's a good thing. These are exactly the kind of markets and companies that did well when we saw a 20% pullback in semiconductors back in February because of the whole saaspocalypse fear back then.
- [26:56]
A
You know, I will say we've had some of the smartest people I know have been on the show and not one has talked about European banks. So standalone bank.
- [27:06]
B
Check out a chart, check out a chart. We have one that looks at US growth versus European banks and European defense. And it's done basically double US growth since late 2022.
- [27:21]
A
I'm going to look up this chart. Maybe we can find it for the show. Gabrielle, where can people find your work online?
- [27:27]
B
So@jpmorganfunds.com that's where you can find our guide to the markets, all our blogs, or on LinkedIn as well, under my name, Gabriella Sanders.
- [27:36]
A
You're prolific on LinkedIn. Everyone should definitely go check it out. Thank you so much for joining the show and we'll do it again.
- [27:41]
B
Thanks for having me. Loved it.